If you’ve ever gone to the bank asking for more capital and been turned down, you know why it is. Banks are typically not interested to heap unlimited amounts of capital on any company that comes to its doorstep, let alone a self-employed entrepreneur.
The companies that banks love to provide capital to generally have the following types of characteristics: Three years of consistent earnings, making good money growing, and retained earnings, which means as you have profits, they’re staying in the company. Great cash flow, cash flow coverage. Your debt payments are less than half of your cash flow, and you have relatively low leverage, which means you have good equity relative to the amount of debt that’s in the company.
If you’re in that situation, the bank’s probably begging you to borrow more capital. The challenge, though, is that a lot of growth companies oftentimes aren’t in that situation. If you are growing, you might not be very profitable because you are spending today for a future growth, or you may have very inconsistent earnings. And if that one doesn’t get you, oftentimes what happens is once you’re in growth mode, your assets are growing, and the only way to pay for those assets is either to put in more capital, or borrow more so your leverage goes up.
The reason banks have this criteria isn’t really because they’re bad people. It is a function of who they look to serve in the market with the product resources they have available.
In general, banks make loans anywhere from three and a half percent to 6 to 8% over what they are paying. Just a year ago the Federal Interest Rate was around 4%. Now it’s 5.25-5.5%. Banks don’t make a huge spread on the capital they provide to companies, so as a result, they have to minimize their risk. They do this by looking for things on their loans like full asset collateral coverage. This means banks want physical assets on the back of the loan.
Banks like to get personal guarantees. They also like financial covenants, meaning they really want you to not just grow, but they want you to grow profitably. All of these are ways banks try to manage you as best as possible and keep risks down because banks ultimately don’t make a big return on their on their investments in the capital that they provide.
If you’re looking for capital, you’re trying to get the best terms. Best terms can mean a lot of things: interest rate, relationship, personal guarantees or covenants, things like that.
It really helps if you can create some competition. If you have more than one offer, you’re sort of able to, you know, put it back on the lender to sharpen the pencil to win your business. It actually gives your lender relationship something to go back to their team to say, Hey, look, they’ve got other offers. If we really want to win this business, you know, we probably need to do something better.
Competition really helps. In order to create competition of five or six different proposals or, 2 to 3, whatever the number is, oftentimes you need to go to a lot of different groups. In my practice, we have an internal discipline where we try to consider and evaluate at least 50 different funding sources that are applicable to the company that we’re representing. Our fundamental belief that competition amongst funding sources ensure the best terms and outcome for the clients of Lantern Capital Advisors.
We look at a lot of different funding options from commercial banks and all the different types of groups offering capital because it’s kind of surprising. In reality, these groups, all compete with one another, not only within the same asset class, but even across different asset classes. While a lot of what we talk about for finance is numbers driven and is logical, there is a part of banking that’s also not conventional wisdom and not always logical.